With Debt Ceiling In Sight, Bernanke, Geithner Warn Of Dire Consequences

The federal government is scheduled to reach the debt limit Monday, and with no deal yet struck, top economic officials are warning lawmakers of the consequences of inaction.

Federal Reserve Chairman Ben Bernanke told a Senate committee Thursday that a failure to raise the debt ceiling could lead to a devastating financial crisis, as he reiterated the argument that he and Treasury Secretary Tim Geithner have been making for months.

A default would be a "black swan event," so rare that it's impossible to fully predict the potentially disastrous consequences, argues a new study leaked by Politico.

The two sides in the debt ceiling debate seem to be hardening, rather than bridging, their differences. Republican lawmakers expressed increased skepticism that a failure to raise the debt ceiling would have serious consequences, while top economic officials repeated the argument that this legislative inaction could lead to a default and spark a worldwide economic disaster.

The worst outcome would be one in which the financial system would again destabilize," Bernanke told the Senate Banking Committee, saying such an event would have extremely dire consequences for the U.S. economy.

The U.S. government must continuously borrow money to pay principal and interest on older debt, which means that if it is barred from borrowing above a limit, it risks defaulting on some of its loans. A missed debt payment, which Getihner said could happen by August 2 if the debt ceiling isn't raised, would send panic through financial markets around the globe, as what is considered the world's safest investment would become compromised, independent economists say.

A default would likely touch off a financial crisis worse than the one the county is still recovering from, Geithner told Congress last month.

Since it appears that no deal will be struck before Monday, the Treasury is expected to initiate the second phase of the program of "extraordinary measures," designed to keep the government out of default. Earlier this month, the Treasury stopped issuing special securities designed to help cities and states manage their debt. Starting Monday, it will be able to turn some government debt held by a federal pension fund into cash, and to block other funds from new investment.

This will allow the government to tread water until August, at which point it might have to default. Republican lawmakers have used the debt ceiling debate as a way to enforce fiscal austerity, saying they will not raise the limit unless they win concessions from their colleagues on the Hill. Obama administration officials have sharply criticized this position, saying lawmakers are essentially threatening to crash the economy in order to achieve a political agenda.

The Centrist Democrat Group Third Way is preparing a study that describes the consequences of default in clear terms. Politico's Morning Money got a draft of the study, which lays out five consequences:

1) Treasury bond rates rise.
2) The stock market drops, potentially sharply.
3) The dollar loses its "special status."
4) Mortgage rates rise.
5) Small business and consumer credit tightens and chokes the recovery.

The study explains:

The United States has the luxury of borrowing money more cheaply than any other country because Treasury bills are the safest investment on earth. But that would no longer be the case with default. Losing this safety feature would be a devastating blow, jeopardizing our ability to borrow at low rates, a huge advantage for America and part of our engine for economic growth.

The group also has a nice graphic that shows these consequences as dominos.

One stumbling block in the negotiations, it seems, is that the two sides in the debate don't view the consequences of Congressional inaction with the same degree of solemnity.

"When you say the drop-dead day is going to be August, I question that," Rep. Tom Rooney (R-Fla.) said, according to the Wall Street Journal . "I'll believe it when I see it."

The so-called drop-dead date, at which the government would likely default, was once July 8. But in a recent letter to Congress, Geithner said tax receipts were stronger than expected, allowing the drop-dead date to be August 2 instead. That revision has apparently increased skepticism on the Hill.

"We are writing to seek clarification and an explanation of the rationale for the Department's August 2, 2011 estimate," reads a Thursday letter from the Republican Study Committee , a House group, to Geithner (hat tip to Politico).

But in multiple letters to Congress, Geithner has made his reasoning clear. He has described the process the government must undertake to avoid default, and he has repeatedly emphasized the "catastrophic" consequences of keeping the debt ceiling where it is.

"We are particularly concerned by the growing belief that hitting the August drop-dead date would be no big deal," Bank of America chief economist Ethan Harris said in a new note, according to Business Insider .

Harris says there's a 60 percent chance Congress will delay raising the limit until right before the deadline. And there's a 30 percent chance Congress will blow past the deadline, Harris says in the note.